We Like These Underlying Return On Capital Trends At Redcentric (LON:RCN)
What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. With that in mind, we've noticed some promising trends at Redcentric (LON:RCN) so let's look a bit deeper.
Understanding Return On Capital Employed (ROCE)
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Redcentric, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.10 = UK£9.9m ÷ (UK£185m - UK£86m) (Based on the trailing twelve months to September 2022).
So, Redcentric has an ROCE of 10.0%. On its own, that's a low figure but it's around the 9.1% average generated by the IT industry.
See our latest analysis for Redcentric
Above you can see how the current ROCE for Redcentric compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Redcentric.
What Can We Tell From Redcentric's ROCE Trend?
Redcentric is showing promise given that its ROCE is trending up and to the right. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 134% over the last five years. Basically the business is generating higher returns from the same amount of capital and that is proof that there are improvements in the company's efficiencies. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. The current liabilities has increased to 46% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.
What We Can Learn From Redcentric's ROCE
As discussed above, Redcentric appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 89% return over the last five years. In light of that, we think it's worth looking further into this stock because if Redcentric can keep these trends up, it could have a bright future ahead.
One final note, you should learn about the 3 warning signs we've spotted with Redcentric (including 1 which shouldn't be ignored) .
While Redcentric may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
Join A Paid User Research Session
You’ll receive a US$30 Amazon Gift card for 1 hour of your time while helping us build better investing tools for the individual investors like yourself. Sign up here
